One way of putting which is that increasing
labour productivity in services is more difficult than improving it
in manufacturing. Canonically, we cannot get a symphony orchestra
to be more productive by playing at twice the speed. So, ally this
with wages being determined by average productivity, we'll see the
amount we need to spend on labour to get services to rise against
the amount we need to spend on labour to get manufactures. Services
will become more expensive relative to manufactures over time.

However, this is not certain. A tendency,
yes, but not a certainty. For it is possible, through innovation,
to turn a service into, if not a manufacture, at least an automated
operation. Think replacing bank clerks with ATMs. Skilled typists
with dictation software. We can record the symphony once and play
it many times on a gramophone/Walkman/iPod.

Which leads us to another part of Baumol's
work. What system, what structure, boosts innovation?

Note that "innovation" here is not taken to
mean the invention of new stuff. Rather, the dispersion of such new
inventions through society, enabling people to think up ways of
using it in new and interesting ways: boosting labour productivity
as they do so.

One point he makes is that the Soviets
invented some pretty spiffy stuff but as anyone who was there
either during those times or in the rubble following 1991 will
know, almost none of it ever got used by anyone.

No, it's a market system that encourages the
use, experimentation with and thus improvements in productivity,
that new inventions allow. Planning doesn't, the State doesn't,
markets do.

Which brings us to our conclusion.

Let us agree that middle incomes in the US
have been stagnating (they haven't, just not growing very fast
but….). Let us also agree that we'd rather like to get them rising
again.

It's that nontradeable sector, healthcare
especially, which we need to worry about, the one where innovation,
which determines labour productivity and which in turn determines
general wage levels, is more difficult. And the way we know how to
increase innovation is through having a market based economic
system.

Another way of putting the same sort of point is that inventions
are only any good (for raising the standard of living) if they
cause time-saving in the fulfilling of your needs. The more we do
that for some needs, the bigger loom the needs we have not yet so
improved. Fifty years ago, people spent a lot of their income on
food. Now we have made food so cheap, time-saving in the production
of food hardly touches people's lives. A new model of combine
harvester results in a tiny improvement in the cost of a shopping
basket. But because food is so cheap, people can afford to spend a
lot of their income on health, a sector that is very good at life
saving, but not much good at time-saving productivity improvements
(especially because either tax funding or insurance funding gets in
the way).

Presumably this is why catch-up growth in China is faster than
pack-leading growth in America and Japan and Europe. The easy
industries are being mechanised and efficientised first.